Land for Love and Money

by Reid Lance Rosenthal

  If a loan has not performed perfectly, i.e., there have been any delays in payments, the examiners “think” the market is changing, the bank has other problem loans which make all loans suspect and a host of other reasons, the file is flagged. Discussions take place between the bank and the examiners as to how to handle the files. Some files are simply flagged and left for review at the next examination. Others are “classified.” In simplest terms, classification means an asset is not performing, or underperforming. If you had to rearrange a loan structure with a lending institution in which interest rates were lowered, principal payments were deferred, or virtually anything not exactly like the original loan documents was negotiated, this loan is probably now viewed as underperforming. Nonperforming means nothing at all is being paid.

  Tightening the Regulatory Noose

  There are five levels of classification, “pass, special mention, substandard, doubtful and loss.” Level I, which is called a “pass”, is the least onerous. Level five, “loss”, is most severe. Under current regulations, any classification from pass and downwards, requires the bank to take a certain portion of its capital—in simplest terms its equity in its business—and reserve against it. Since banks can make loans based on a percentage of their capital, this frozen portion of the capital means they can make fewer loans. Less loans means no financing for you, and decreased profitability for the bank. At level five, loss, the reserve is 100% of the loan amount. You can see how a smaller bank, if the examiners have classified a number of loans at levels four or five, can suddenly have less capital than regulations require. That’s when a bank “fails” and is taken over.

  A Dark History—Now Repeating

  How Your Money Funds Guaranteed Profits to Others

  When the Savings & Loans (S&L) ran into this problem in the early and mid-1980s the assets of failed thrifts which is virtually everything and includes all loans—were transferred to the “Acquirer”. The Acquirer is the bank that stepped into the shoes of the failed S&L. In those days, thirty years ago, the “broker” was the Federal Savings and Loan Insurance Corporation (FSLIC). A shell bank was set up called the “bad” bank. Loans that would not pay off, or were not paying in full in the estimation of the regulators, went to the bad bank. Loans that were performing went to the good bank, i.e., the reconstituted savings and loan which had been acquired by the Acquirer.3

  Later, the government set up a new layer, the RTC, or Resolution Trust Corporation, which in effect was a shell that cloaked the FDIC, the “real party in interest.”

  The process is now administered directly by the FDIC. Many of you have likely already experienced the failure of a lender. Many more of you will. I am currently involved in two separate situations involving failed lenders. They are not any fun. Many times, the people of the failed bank with whom you have developed relationships with over the years are gone, replaced by persons you’ve never seen or heard of, who must get approval for everything from the acquiring bank, which may be one thousand miles distant, not even a real estate bank, has never seen the land and surely knows nothing about your market area. The acquiring bank is driven strictly by an agreement called the Loss Share Agreement between it and the FDIC. It is guaranteed a significant profit if it follows the agreement. The Acquirer will make no moves, no matter how sound for the land, collateral, tax payers and others, if such action interferes with the Loss Share Agreement. When I tell you why, you will be less than pleased.

  Guaranteed Profit—From YOUR Pocket

  The sordid truth is that the acquiring bank has purchased the assets of the failing bank at a significant discount. However, the FDIC, through the Loss Share Agreement has guaranteed the acquiring bank face value of the assets.

  Additionally, the acquiring bank is insulated completely from all cost and loss. That means the acquiring bank and its legal counsel have carte blanche to spend taxpayer money. So long as they follow the edicts of the Loss Share Agreement—which typically restricts just about any common sense business approach to handling real estate, lending, assets and borrowers—not only are they guaranteed no loss, they are guaranteed a profit. That profit is a difference between what they purchased the assets for and the face amount of the assets.

  Let’s say you have a $500,000 loan. Your bank fails, and is taken over by an Acquirer via a Loss Share Agreement. The Acquirer purchased your $500,000 loan for somewhere between $250,000 and $400,000. Whatever steps it takes, or does not take, and all the costs and expenses associated with those steps, or lack of steps, will be reimbursed to it by FDIC—which is you, the taxpayer. At the end of the day with all costs covered, no risk—and no reward if prudent business practices are followed—the acquiring bank will get $500,000 even though it paid far less for the asset. The difference is paid by you, the taxpayer.

  It does not take a Ph.D. in economics to understand that there is no incentive whatsoever for an Acquirer, or the FDIC, to do anything. The same is true for their attorneys. The attorneys basically feed off an annuity, which is the United States Treasury. That the lack of application of common sense in a situation like this will hurt the surrounding market area, thereby further crippling the value of the portfolio of the Acquirer—or other banks—seems to make no difference. That, with time, an asset has plenty of value and could pay off everyone in full including profit, saving the tax payers any cost, means nothing. That the advance of a small amount of money for improvements which would create additional operational cash flow, which would in turn cover the debt service during the holding period, is not relevant. The effect on the rest of the market or the real value of the real estate has absolutely no bearing on the decisions, or lack of decisions made.

  Those of you who have experienced this unfortunate situation know that whatever agreements the failed bank had with you, particularly if verbal, mean nothing to the acquiring bank and the FDIC. You’ve entered a brave new world where business sense has no footing or worth, and—as has been admitted directly to me—the borrower, the taxpayer, the asset, the market, the stability of other banks with loans in the market, all come second to the acquiring bank’s adherence to Loss Share Agreement (its ticket to guaranteed fat profits). In summation, the acquiring bank is guaranteed a profit, piggybacked on the borrower’s equity in the land or real estate, all paid for by the United States taxpayer.

  At least the rape and pillage inherent to the old FSLIC Assistance Agreements is a bit less. Discounts of 10 to 60%, via the Loss Share, though still incredible, are better than some of the deals made “way back when.” I am personally familiar with a FSLIC deal in which a $27 billion thrift was acquired by a wealthy family from Texas. There was purportedly $9 billion in nonperforming assets that went to the “bad bank.” The other $17 to $18 billion in performing assets went to the acquiring bank. For that $17 billion in assets, this family paid $100 million. They were paid millions per month to manage the bad bank, which was a shell with no—zero—employees. The FSLIC Assistance Agreement in that case even provided forgiveness of up to $50 million in fraudulent management of these assets every three years. I wish I was making this up, but I’m not. More on this amazing story in Volume Two.

  What does all this mean to you as a purchaser of land? Do some research on the bank to which you apply for, or have, a loan. If you’re caught in the unfortunate quandary as described above, subsequent volumes of Land for Love and Money will give you some ideas and cold hard strategies to employ in your attempts to extricate yourself from a morass not of your own doing.

  This all brings us to the silver lining in the sorry state of lending affairs. There are bright rays of sunshine in the darkest clouds. As dire as the current conventional finance situation is for land buyers there is a way to turn these financing obstacles to your advantage, whether you are a buyer or seller of land. It doesn’t involve the government, the banks, overbearing regulations, and it’s as flexible as you and the other guy at the table want to make it.

  1For detail on FIRREA and other statutes refer t
o url link in the Resources section.

  2The bank hires a second appraiser to “re-appraise” and/or review the initial appraisal.

  3Additionally, Acquirers were generally paid a management fee for so-called supervision of the assets of the “Bad Bank”.

  Appraisals have always been important to real estate lending, and valuation but with the avalanche of regulations descending upon property ownership, purchase, sale, realty work, and banking, appraisals have become critical.

  There are very few appraisers that do not have distinctive professional designations.1 There are many levels of appraisal designations, and appraisers wear their badges proudly. Some of the most common are:

  MAI, Member of Appraisal Institute

  SRA, Senior Residential Appraiser

  ARA, Accredited Rural Appraiser

  The great majority of appraisers are hard-working, conscientious, conduct intensive research, have an extensive intelligence network, travel incessantly, and put in long hours. As with any industry, there are always a few bad apples. The government, in its zeal to protect us all and expand its swath of control, has instituted regulations via the new financial regulatory laws, which in certain cases can make appraisers liable for “bad” appraisals. Fines start at $10,000.

  Various segments and locations of real estate markets each have their own peculiarities. Any appraiser can do the paper research necessary to do an appraisal. In my opinion, the only real appraisals are by appraisers who specialize in specific types of real estate, have built a network for market intelligence (which becomes part of the appraisal), are conversant in localized market trends (which can affect realistic assessments of value and perceptions of demand) and go out and kick the dirt. Appraising a house is a whole different animal than appraising an acreage, and even further removed from a farm and ranch appraisal. Appraisers consider all aspects of the property: location, type, amenities, income and replacement cost. Appraisals are sometimes predicated on the estimated completed value of a structure from plans (i.e., not yet built) or, a piece of land “as improved” (improvements to be completed in the future tense). These valuations are used to project pricing based on completion of future improvements.

  New regulations have greatly tightened what appraisers can use for “comparables”. Comparables, also referred to as “comps”, are properties similar to the property being appraised, located in the immediate or “like market” areas. The new regulations that govern appraisals due to so-called financial regulatory reforms include both tweaks and substantial changes to methodology that an appraiser may employ. As a few examples:

  comparable property sales must be closed within last 12 months

  appraiser must note any nonconforming aspects of the property

  appraiser must, where possible, discard the highest and lowest of their comparables

  IMPORTANT! Listings (unsold properties) don’t count. Only properties sold and closed may be used as a comparable.

  Currently, a combination of regulations and lender policies dictate that there must be a minimum number of comparables. Under the new guidelines, log and certain other homes are “nonconforming.” More on this later in the chapter. Guidelines and regulations are definitely geared to the typical exurban, suburban and in-city real estate. Finally, comparables of rural property are subject to distance restrictions (often a “comp” must be within a mile, five miles or seven miles of the appraisal property). This can be problematic when your nearest neighbor is more than seven miles away.

  Understand that your final loan approval, no matter what type of commitment letter you think you have, is always subject to the appraisal. And the bank will loan only a certain percentage, the LTV, of the final appraisal value. A low appraisal can blow your budgeting, or the deal, to the four winds.

  Let’s assume you are buying a piece of land, with a home, for a purchase price of $300,000. The buyer has, of course, told you what a terrific deal you’re getting and how they can barely let it go for that price. Your realtor has enthusiastically assured you—and believes—that this is a great value for the market. You budget a 20% down payment, ($60,000) and plan to borrow 80% ($240,000) of the purchase price. Everyone assumes that there will be no problem with the appraisal, which will come in at least at $300,000 or more.

  The appraisal does come back at $300,000 but the review appraiser, who typically never sees the property and just works off paper, determines the proper valuation is $280,000. Or, perhaps the initial appraisal comes in below the purchase price. The buyers and sellers now have a quandary. If the contract is written properly, either can walk, and the earnest money will be refunded to the buyer. The contract should also provide for the parties to get together when a problem like this arises to see if they can work it out prior to either party electing to terminate.

  Let’s assume, in our example that the sellers are unwilling to lower the price to conform to the appraisal. A lesser price would obviously take care of the buyer’s problem, but could adversely affect the seller’s budget, or, as is often the case in the current economy, might not generate enough cash for the seller to pay off the debt on the property because values have fallen. In this case, you, the buyer, have a decision to make. If you really love the property, it speaks to you, and it works on many different levels for all aspects of your life, you might proceed with the purchase. However, your loan amount can now not exceed the approved LTV, let’s use 80% of $280,000. If the buyer sticks to their $300,000 sale price you will be taking $16,000 more out of your pocket to complete the closing.2 Over the past several years, these types of situations have become more prevalent, so this possibility needs to be kept in mind.

  The appraisal “gotcha” also affects sellers. You can price a property at whatever you wish, but it’s unlikely to appraise at that higher value if the property miraculously does sell. So, any contract that does come in will probably not close. A buyer, after investing the time and emotional energy to decide to purchase, to write a contract, negotiate that document, and begin to jump through the hoops of obtaining financing, will not be pleased. You, as the seller, will have lost valuable marketing time, particularly critical to rural properties that show far better in the spring, summer and early fall months, than in late fall and winter.

  I have a colloquialism I like to invoke, which unfortunately I have not always followed. There will be several stories of the resulting disasters further in this, and future volumes. Pigs are fat and happy, and hogs get slaughtered. In other words, it’s okay to negotiate hard and smart for the best possible price, but if you get greedy, bad things will happen, the least of which is losing the sale.

  Don’t Be a Non-Conformist

  There are other interesting and frustrating wrinkles in the new appraisal guidelines. One of the most onerous is the evolving definition for “conforming property.” The list of properties that “conform” in the minds of whoever dreams up this stuff is shrinking. Certain types of foundations no longer qualify for mortgage financing, cinderblock in many locations being one example. Log homes, though always in a special class, are no longer considered conforming. That should prove rather distressing to the million or so people who own log homes. Certain types of water supply systems, septic treatment systems, access roads, distances from fire departments, even rural fire departments, can throw a loan (on land that contains structures or a residence) into the “nonconforming” class. The result is an immediate decrease in the value of these properties, and huge, sometimes insurmountable hurdles for sellers who suddenly own nonconforming real estate. A nightmare of financing complexities arise for the buyer. Appraisers are being told to discount the value of such properties. The fact is most lenders won’t touch them, unless perhaps via a short-term commercial loan, and even then reluctantly.

  This true story will drive home the point. Just in the past several years I took on a client as a buyer’s agent. She was looking for rural property twenty to thirty miles from a university town in the Rockies. The purchaser was emine
ntly qualified—perhaps golden in this day and age—virtually no debt, excellent credit, enough money for the down payment and a secure, high-paying job. She had no real estate to sell so she was not tethered to the past. We found a beautiful, twenty-four-hundred square foot cabin needing completion on forty acres, with a creek, privacy, surrounded by large ranches, within the commuting distance she wished, and all at the right price. She was prequalified for her mortgage.

  She cut a good deal with a pleased seller who had been trying to sell his property for a year. Then came the process of attempting to convert her prequalified mortgage into a loan for closing. The first obstacle was a limitation on acreage. No mortgage lender would touch the deal if it was over eight acres. I was familiar with this “gotcha” and a surveyor quickly surveyed a mortgage exemption parcel3 of eight acres. Ah! Problem solved! Not so much.

  Shortly before her contract, log homes had been relegated from their specific class to “non-conforming.” I was not aware of this “down grade”. Because the home was log, several mortgage companies turned it down flat. One other company said they would consider it at a greater cost and higher interest rate, but they had to have three comparables within seven miles—an obvious impossibility in a rural area having few homes, fewer still log structures, and very few sales, in fact, virtually no properties on the market. Finally, at my suggestion, she approached a commercial bank. The best the bank could do was a five-year, short-term loan at an onerous interest-rate for this day and age, and only if they slapped a hefty 30 to 40% down payment on the table. The bank never really clarified how much. They were less than enthusiastic about tackling the deal.